In part of one of my previous posts, I made a reference to the fact that a recession can/should reset prices and cleanse the markets. This idea goes beyond price and demand bubbles. It also applies to the use of credit. As I’ve said, easy money, backed by the fed through freddie and fannie, caused the unnatural increase in demand for housing which snowballed by bringing in an unnatural amount of speculators, causing the bubble. That easy money overflowed into every corner of the markets. So now that it has been cut off, we are seeing the effects.
I’m of two minds concerning what to do. The conservative and principled part of me sees the absurdity of overuse of credit, and wants to say that cutting it off should teach businesses, government, and individuals to learn how to better live within their means, something this country needs badly. (that’s the cleansing effect I’m referring to)
Alas, I afraid the other part of me might be more practical. I think they’re going to take away my libertarian decoder ring for saying this.
You see, you can’t just take the heroin away from the junkie because the withdrawls might kill him. You have to ween him off it. It seems terribly ironic that we give addicts perscription drugs that are often equally addictive as their illegal counterparts. But, what choice do we have? When you switch a heroin addict to methadone, there’s a small chance he will kick the habbit. Most likely, he will just live out his days addicted to methadone instead of heroin, but it’s even more dangerous to cut him off completely.
Our credit problem is much the same. Many businesses cannot operate without spending next quarters’ earnings, simply because they have become so used to operating this way. If credit ceases to flow, our economy suffers from withdrawals.
The irony is much the same as in my analogy. The problem was caused by government-backed over-leveraging, and we are attempting to solve it through more leveraging. Injecting liquidity into the credit markets to deliberately re-expand credit, when the problem was caused by too much credit in the first place (easy money).
Am I saying that the current Fed action is correct? No. But it might be necessary. I’d love to say let’s go cold turkey; It might be a decade before we see real growth again, but at least it would be growth built on hard work, rather than growth built solely on credit. The problem is, I’m not sure we can survive the detox.
Of course the problem in all of this is that I in no way trust congress or the Fed to handle this the way it should be handled. That is, inject JUST ENOUGH credit to keep things alive while business get their accounting practices back on solid ground. Then slowly draw back the artificial credit expansion so that credit once again becomes a function of mutual benefit of both borrower and lender. (with REAL default risks written into the rates, as opposed to ignored because of Fed backing and rate-fixing).
Instead, I’m afraid the economy is just going to be addicted to methadone instead of heroin.